StoneCo Ltd. Q1 FY2021 Earnings Call

Good evening, ladies and gentlemen and thank you for standing by. Welcome to the StoneCo First Quarter 2021 Earnings Conference Call. By now everyone should have access to our earnings release. The company also posted a presentation to go along with this call. All materials can be found at www.stoneco.com on the Investor Relations tab. Throughout the conference call, the company will be presenting non-IFRS financial information, including adjusted net income and adjusted free cash flow. These are important financial measures for the company, but not all financial measures are defined as IFRS. Reconciliations of the company’s non-IFRS financial information to the IFRS financial information appears in today’s press release. Finally, before we begin with our formal remarks, I would like to remind everyone that today's discussion might include forward-looking statements. These statements are not guarantees of future performance, and therefore you should not put undue reliance on them. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from the company’s expectations. Besides, we would like to remind you that the Linx acquisition is pending regulatory approval by the Brazilian Anti-trust Authority and management comments are based only on publicly available information. Please refer to the forward-looking statements disclosure in the company’s earnings press release. In addition, many of these risks regarding the business are disclosed in the company’s Form 20-F filed with the Securities and Exchange Commission, which is available at www.sec.gov. Please note this event is being recorded. I would now like to turn the conference over to your host, Rafael Martins, Vice President of Finance and Investor Relations Officer at StoneCo. Please proceed, sir.

Thank you, Operator, and good evening, everyone. Joining us here today we have Thiago Piau, our CEO; Lia Matos, our COO and Chief Strategy Officer; and Marcelo Baldin, our CFO. Today, we will present our operational and financial metrics for the first quarter 2021 results and discuss some observations we are making in the second quarter. I will pass it over to Thiago, so he can share with you the key messages regarding the quarter and future outlook. Thiago?

Thank you, Rafael, and good evening, everyone. While Brazil faces the challenging situation with the second wave of COVID in the first quarter, we continue to work hard to stay close to our clients and bring them the best service and solutions we envision. We monitored our client activity closely, as well as how vaccinations and economic activity evolved in Brazil and in other countries. Based on our experience with lockdowns last year, recent client transactional data, and insights from countries where vaccines are widespread, we expect that once vaccinations scale, which we anticipate in the second half of 2021, the economic recovery will be fast. Although delayed, it looks like Brazil is moving in the right direction. In order to be the fastest player when our economy returns to normal levels, in the first quarter, we decided to increase our investments in our operation. We have a high-quality and solid core business in terms of growth, profitability, and cash flow generation that continues to scale both in client base and TPV while also increasing engagement among clients with new solutions. Our core SMB business presented strong growth metrics in the quarter and to date. As Lia will detail shortly, our active payment clients in SMB grew 67% in the quarter versus last year, achieving 857,800 active clients. Among these, 257,000 clients are active in our digital accounts, and of those, 188,000 use it as their banking domicile, settling all of their transactions in the Stone Account. Overall, SMB TPV grew 45% in the first quarter compared to last year, with strong acceleration in the second quarter to date, where TPV grew 121.6% in April and 111.2% in May up to May 20th. While April and May compare to weaker comps due to lockdowns in the second quarter of 2020, we still see strong growth acceleration when looking at a two-year CAGR of 42% and 50% annual growth, respectively, in April and May to date. In terms of revenue and profitability in our core SMB operation, our take rates decreased from 2.2% in the first quarter of 2020 to 1.87% in the first quarter of 2021, due to additional provisions on our credit products caused by commerce restrictions. Excluding these effects, we believe our take rates would have been 2.22%. Even though we experienced an R$116 million impact in revenue reduction, our credit portfolio grew and remains healthy, achieving a risk-adjusted return net of funding costs between 1.5% and 1.9% on a monthly basis, notwithstanding the short-term impact from COVID. We continue to evolve our strategy to fund our products with third-party capital and thus limit our exposure to credit risk. We have recently concluded another issuance of FIDC, raising an additional R$340 million in third-party capital. In total, we now have available R$833 million in third-party funding to be disbursed in our credit operation. Regarding our vision and product evolution, we are building a complete financial operating system for SMBs. In the past, we took the approach of building separate solutions as it was the best way to grow fast, learn about the market, and gather client feedback. We have now decided to integrate our solution set and have already migrated approximately 70% of Stone’s SMB client base to our new platform. Regarding our software strategy, we will continue to invest in and acquire brick-and-mortar POS and ERP solutions built by talented individuals focused on strategic verticals where we have great chances of integrating our financial operating system and executing the digitization of commerce to assist our clients in selling online. The acquisition of Linx, which is still pending anti-trust approval, is a significant step towards our vision and will broaden our vertical coverage, as well as expand our set of digital solutions. With this acquisition, we anticipate reaching R$1.1 billion in annualized pro forma revenue in software. By executing both on the Stone SMB core business and our software strategy, we believe that we will be in a much stronger position to capture the evolution of the approximately R$4.7 trillion GMV of household consumption. We seek to be the player that best assists our merchants in doing business and reaching consumers. To that end, our investment in Banco Inter and the commercial partnerships we are building will be very beneficial in terms of learning and new experiences. We are very confident in the growth of our core business and excited about the opportunities ahead. We will work hard as protagonists in the financial and commerce revolution of our country, finding the best people we can and serving our clients with maximum care and devotion. With that said, I will pass it over to Lia. Lia?

Thank you, Thiago, and good evening, everyone. Thanks for joining us today. I want to start our presentation on page three by highlighting that Brazil went through a second wave of COVID in the first quarter of 2021, which imposed commerce restrictions in several cities throughout the country. Those restrictions were felt by our clients, with average TPV reaching a low at the end of March. But similar to the behavior we observed during the recovery from the first lockdown in 2020, we already observed significant and quick recovery, with average TPV in May achieving levels above January 2021. As Thiago mentioned, we expect that once vaccination scales, the economic recovery of the country will be fast. On page four, we illustrate our decision to increase investments in the growth of our business. We want to be ready to accelerate growth when our economy returns to normal levels. Indeed, when we compared to the previous quarter, we increased our sales team headcount by 24% and our marketing investments by 33% to ramp up our distribution capacity. We expanded tech headcount by 20% to drive the evolution of our platform and solutions further, and we increased our customer service and logistics teams by 32% to continue to provide the best service to our clients as our operation scales. On page five, I would like to highlight the performance of our SMB business. From now on, when we refer to SMBs, we are referring to our brick-and-mortar SMBs, SMBs that sell online to Pagar.me, and TON, our micromerchants solution. We continue expanding our SMB client base, which has increased 67% year-over-year, reaching close to 858,000 clients in the first quarter of 2021, with quarterly net additional clients of 138,000. Of those, over 62,000 are coming from online and offline SMBs, and close to 77,000 are coming from TON, a strong acceleration compared to last year. With the strong growth in TON, we are excited about the opportunity to become a relevant player in the micromerchants space. The number of open digital banking accounts increased to over 658,000, 30% higher than the previous quarter and 5.4 times higher than the first quarter of 2020. Clients with an active digital banking account reached more than 237,000, demonstrating an increasing level of engagement. From now on, we will only disclose the number of active accounts. Also within these accounts, more than 180,000 clients are already using Stone as their main settlement account. The number of clients using our working capital solutions has also grown significantly. The number of clients using credit increased threefold year-over-year, reaching more than 102,000 in the first quarter of 2021, and the percentage of clients with prepayments grew from 62% in the first quarter of 2020 to 67% this quarter, a 5 percentage point increase. Moving over to page six, we show the TPV evolution of our SMB operation, which grew 45% year-over-year in the first quarter and has accelerated to 122% in April and 111% in May, up to the 20th of the month. Looking at a two-year CAGR to normalize the effects from weaker April and May in 2020, we see our SMB clients' TPV accelerating growth in May to over 50% two-year CAGR even with the impact of COVID in 2020 and 2021. On page seven, we highlight the performance of our credit operation in the quarter. Our take rates decreased as a result of an increase in our credit provisions and financial incentives to clients, due to commerce restrictions imposed because of the COVID second wave. This measure brought a negative impact to our results of R$116 million or 35 basis points in the SMB take rates. Consequently, our take rates in SMBs decreased from 2.2% in the first quarter of 2020 to 1.87% in the first quarter of 2021. If we were to exclude these effects, we believe our take rates would have been 2.22%. Even though we have experienced this impact, our credit portfolio has grown and remains healthy, with monthly returns between 2.1% and 2.5% or between 1.5% and 1.9% when we already discount the funding costs. The total credit portfolio grew from R$1.5 billion in the fourth quarter of 2020 to R$1.9 billion in the first quarter of 2021. We continue to evolve our strategy to fund our product with third-party capital and thus limit our exposure to credit risk. As of the second quarter of 2021, we concluded another issuance of FIDC raising an additional R$340 million in third-party capital. We now have a total of R$833 million available in funding to be disbursed in our credit operation. This second FIDC was raised at a cost of CDI plus 3.76% versus CDI plus 4.88% in the first issuance, lowering our marginal cost of funds by 112 basis points. As we show on page eight, the traction and engagement of our ABC Platform continues to increase. The heavy users of the platform, defined as clients being active in payments, credit, and banking products, reached 7.7% of the total in the first quarter of 2021, compared to 5.3% in the previous quarter and only 0.4% one year ago. Also, we saw more clients being active in at least two financial solutions, with the number growing from 34% in the fourth quarter to 41% in the first quarter of 2021. On page nine, we discuss our vision and product evolution. As Thiago mentioned, we’re building a complete financial operating system for SMBs, both online and offline. We have reached where we are today by developing different solutions to help our SMB clients with their financial needs. We built the ABC Platform to assist brick-and-mortar SMBs with an integrated payments, banking, and working capital offering. This was an important step to drive the activation of new financial solutions beyond payments. We have already migrated approximately 70% of the SMB client base to this new platform and continue to see increased engagement. At the same time, we have enabled SMB clients to sell online through our Pagar.me platform. More recently, we launched our TON solution for micromerchants and acquired additional solutions to help our clients with value-added services, such as reconciliation and loyalty. As we have increased scale in those solutions, we have taken the challenge to integrate Pagar.me, SMB and TON products into the unified experience of the ABC Platform. As shown on this page, I want to highlight the elements of this platform in four feature sets. Money-In, where we enable clients to collect money from their sales and cards and other non-cash payment methods, such as Pix, wire transfers, Boletos, and vouchers. We are evolving to enable reconciliation of all payment methods and providers as well as online sales with risk management and chargeback disputes. One of the most critical needs of our clients is working capital, and we address those needs through prepayment and loans. Once our clients cash in their sales using our platform, they can take working capital solutions to help them grow their businesses. We aim to assist them with a complete set of Money-Out features, such as bill, tax, and Boleto payments, wire transfers, Pix, and card payments for other business-related expenses, along with cash withdrawals. We are working hard to launch our payroll feature, so our clients can easily pay their employees. As our solution evolves, we will offer value-added services integrated into our core platform, such as loyalty and CRM. Now I want to show you some metrics to illustrate the evolution of these funds. On pages 10 and 11, we present engagement metrics of current users of the platform. While our TPV grew 45% compared to the previous year, banking, money, and volume, which mainly include fed, Pix, and Boleto grew 4.6-fold year-over-year to R$2.6 billion. Finally, our total account balance increased 5 times, reaching nearly R$614 million in the quarter. In Money-Out, prepaid card TPV grew close to 5 times year-over-year, reaching nearly R$290 million in the first quarter, driven by increasing penetration and adoption of cards within our overall client base. Banking Money-Out volumes composed of tax, Pix, Boleto, and bill payments grew 5.7 times year-over-year, reaching almost R$9 billion in the first quarter. Our working capital solutions also continue to scale, with the credit portfolio increasing to R$1.9 billion, while we raised the percentage of the portfolio being funded with third-party capital from 4% in the fourth quarter of 2020 to 17% in the first quarter of 2021, as I already mentioned. To date, we have R$833 million in third-party funding for our credit solutions. Additionally, in prepayments, we increased the total prepaid volume in the segment by 38% year-over-year, fulfilling our clients' working capital needs during this challenging environment. Moving on to pages 12 and 13, we show how our vision and software have evolved. Back in the second quarter of 2019, we communicated our vision to investors, and since then, we have taken several steps to help merchants of all sizes with their workflow tools to drive their digitization and growth. As Thiago already mentioned, we have taken the approach to invest in and acquire POS and ERP software businesses with two main opportunities for value creation. Number one, to upsell financial services, and number two, to select segments where we could drive the digitization of commerce. The acquisition of Linx, which is still pending anti-trust approval, is a significant step towards achieving our vision and will broaden our vertical strategy, as well as expand our set of digital solutions. On page 13, we highlight where we are in the evolution of our vision and how the Linx acquisition will enhance our software ecosystem. Our current POS and ERP solutions cover retail, food, and service verticals for SMB. With Linx, we will expand into new verticals such as fashion, pharma, and gas stations, while gaining strength in mid/large clients. Our strategy will continue to focus on expanding our presence in strategic verticals through M&A and supporting organic growth within each vertical. Additionally, with Linx, we will enhance our presence in the digital space by helping large brick-and-mortar merchants to go omnichannel through Linx OMS, as well as assisting SMB and mid/large retailers to sell directly to their consumers through eCommerce platforms, marketplace gateways, and food delivery apps. We help our clients engage with social media and with Linx's improved products, we will expand the offering of engagement tools and help merchants better attract and engage with new consumers. Moving to page 14, we present some numbers showcasing our evolution in software. Our pro forma revenue reached R$55.2 million in the first quarter of 2021, with organic growth of 43% year-over-year. If we include numbers from Linx, our pro forma revenue would have reached R$285.8 million, growing 16% year-over-year. In annualized terms, our combined revenue would have surpassed R$1.1 billion. From this quarter onwards, we decided to exclude from our reported numbers of subscribed software clients the SMB clients using our reconciliation and loyalty tools since those solutions are being integrated into the ABC Platform and will be treated as value-added services. With that, we have achieved 133,000 clients in the first quarter of 2021, and when combined with Linx, total client figures would have reached 202,000 in the quarter. On pages 15 and 16, we present the evolution of our client base and pro forma revenue by segment. I would like to highlight two important data points: First, we achieved R$174.7 million in pro forma revenues from POS and ERP solutions with 47,900 clients in SMBs, and second, we reached R$1.6 billion in GMV in digital solutions considering both eCommerce platforms, OMS, and food delivery apps. Finally, we seek to be the player that can best help our merchants do business and reach consumers. Our investments in Banco Inter that we discussed on page 17 and the commercial partnerships we intend to build with them will be an essential step in that direction. For those not familiar with Banco Inter, it is a leading digital bank in Brazil, with a growing client base of 10 million active users and a complete suite of products and services for individuals, including banking, marketplace, credit, insurance, and investments. We are investing up to R$2.5 billion for a maximum of 4.99% stake in Inter. Additionally, we will have a seat on their Board and will be entitled to a right of first refusal for a period of six years and under certain price thresholds in case of change of control. We have already engaged with Inter’s team regarding commercial partnerships, such as connecting merchants to InterShop, their fast-growing marketplace, driving the digitization of the merchant base and providing a multi-channel journey for InterShop consumers to enable a seamless mobile payment experience between Inter consumers and Stone merchants online and offline. We also aim to leverage Inter’s funding capabilities to increase efficiency in Stone’s working capital solutions, as well as provide Inter clients access to new investment opportunities in fixed income through offering FIDCs. We are excited to work closely with Inter’s team to drive conversion for its consumers and Stone’s merchants, and we will update you in the future about advancements in our commercial partnerships. Lastly, on page 18, I want to give a quick update on Pagar.me key accounts, our fintech-as-a-service business. We continue to see short-term headwinds in TPV and revenues and expect this trend to continue in the short term. That said, we want to highlight that this is a more volatile business and that its representativeness to our earnings is very small, despite being more relevant in TPV. Although we will continue to evolve Pagar.me key account offering to a broader set of features such as banking-as-a-service and credit-as-a-service, Pagar.me focus will be inclined towards digital native SMBs and the integration with the ABC Platform. In the first quarter of 2021, TPV increased by 21% to R$18.2 billion. In the second quarter to date, up to May 20th, TPV has risen 26% year-over-year. Take rates have decreased from 1.1% in the first quarter of 2020 to 0.8% in the first quarter of 2021, a decrease of 30 basis points, primarily a result of lower prepayment rates, which were impacted by declining CDI rates in Brazil. The take rate net of funding cost has fallen from 0.55% in the first quarter of 2018 to 0.45% in the first quarter of 2021, a decline of 10 basis points. With that, I will pass it over to Rafael, who will discuss our financial results in more detail. Rafael.

Thanks, Lia. Starting on page 19, we show that, as Lia stated, given the volatility in commerce activity due to the pandemic, we have decided to increase provisions for expected losses, which, along with financial incentives to our clients, has negatively impacted our consolidated revenue in the first quarter of 2021 by almost R$116 million and our adjusted net margins by 5.2 percentage points. Our consolidated take rates ex-Coronavoucher decreased from 1.81% in the first quarter of 2020 to 1.63% in the first quarter of 2021, with a 23 basis points negative impact from the effects I just mentioned. This was a similar level of take rate compared to last quarter when we reported a 1.64% take rate ex-Coronavoucher. Total revenue and income grew from R$716.8 million in the first quarter of 2020 to R$867.7 million in the first quarter of 2021, a 21% increase year-over-year. In terms of margins, we had a 21.6% adjusted net margin this quarter. We are already seeing much better trends for our topline in the second quarter, as indicated by Lia before. Moving to slide 20, we show the evolution of the number of active payment clients, TPV, and revenue. Despite the COVID impact, our payment client base grew by 34.5% compared to the first quarter of 2020, reaching 722,300 clients excluding TON. TON has reached 190,300 active clients, posting record net additions in the quarter of 76,600 clients. Our consolidated TPV grew by 35.5% in the first quarter 2021, and for the second quarter, due to the strong performance in the first months of the period and easier comps, we expect significant acceleration in the TPV growth. On slide 21, we discuss our operating leverage and profitability. Our operating leverage was impacted by lower revenue due to the increase in credit provisions and financial incentives to clients, headwinds from COVID-19 in our volumes, and as Thiago mentioned, our decision to continue investing in our business to accelerate growth. Financial expenses also increased as a percentage of total revenue and income due to the combination of a higher base rate in the country, mark-to-market from short-term investments, and the revenue impacts I just mentioned. With that, our adjusted net margin was 21.6%, roughly in line with the first quarter of 2020. Now moving over to each P&L line item on page 22, we see stronger growth in revenue from transaction activities, which grew 40% year-over-year, as well as subscription services and equipment rental, which grew 50% year-over-year. Both lines presented higher year-over-year growth than we saw last year in the first quarter of 2020. Our financial income revenue line grew 2.6% year-over-year, mainly due to the higher provision in our credit business and declines in prepayment rates in Pagar.me key accounts, which were influenced by lower CDI rates in Brazil. Our cost of services reached R$239.7 million or 27.6% of total revenue and income, an increase of 6.7 percentage points compared to the first quarter of 2020. This increase was mainly due to higher investment in our technology and customer support teams, costs associated with our software solutions, higher data center costs to support our operations, and the increase in unit costs of chargebacks. When compared to the previous quarter, cost of services as a percentage of revenue increased 6.3 percentage points, primarily because of operational deleverage from lower revenue, higher investments in new solutions, brand fees related to the increase in the unit cost of chargebacks, higher POS depreciation mainly in TON due to significant increases in the client base, and higher investments in our customer support team. Administrative expenses were R$117.6 million or 13.6% of total revenue and income, up 3.2 percentage points from the prior year period, mainly due to expenses associated with our software solutions. Compared to the previous quarter, administrative expenses increased from 12.2% of total revenue and income to 13.6%, mainly due to lower revenue. Selling expenses were R$162.8 million in the quarter, or 18.8% of revenue, 3.2 percentage points higher than the prior year period, mostly explained by higher marketing investments, particularly in TON. Compared to the previous quarter, it increased 4.8 percentage points as a percentage of revenue, largely due to the lower revenue, an increase in our salesforce headcount, and higher marketing expenses. Financial expenses were R$92.5 million, a decrease of 37.7% compared to the prior year, mainly due to lower cost of funds driven by both the lower base rate and higher use of own cash to fund the prepayment operation, which more than compensated for the higher volumes in the quarter. When compared to the previous quarter, financial expenses as a percentage of total revenue and income increased from 6.4% to 10.7%, mainly explained by lower revenue and higher cost of funds attributed to the increased Brazilian base interest rate. Other operating expenses were R$41.5 million in the quarter, compared to R$3.5 million in the first quarter of 2020. This difference mainly relates to unusually low share-based expenses in the first quarter of 2020 due to lower tax and social charges provisions because of a high depreciation of shares in that quarter and fair value adjustments of call options related to affiliates, labor contingencies, and tax claims, which collectively impacted other operating expenses in the first quarter of 2021. When compared to the previous quarter, other operating expenses were 54% or 4.2 percentage points lower as a percentage of our revenue. This lower figure is primarily linked to a higher share-based expense related to tax and social charges provisions resulting from the appreciation of shares in the fourth quarter, a R$10 million donation to assist with the construction of a factory for the production of COVID-19 vaccines in the last quarter, and higher than usual POS losses due to the COVID-19 impact on SMBs in the fourth quarter. Turning to cash flow on page 23, we reported negative adjusted free cash flow of R$299.8 million in the first quarter of 2021, compared to a negative R$122.3 million reported in the first quarter of 2020. The adjusted free cash flow figure for the first quarter of 2021 was impacted by R$230 million in prepaid marketing expenses due to the agreement with Grupo Globo, R$160 million in prepaid POS purchases, and R$46 million in prepaid software licenses. It's important to highlight that the prepaid CapEx in the quarter was driven by opportunities to realize attractive discounts from suppliers. In addition to the adjusted free cash flow figures for the first quarter of 2021, I would like to highlight some important recent events regarding capital allocation. This year, we completed our repurchase program as announced on May 20th, having purchased a total of 3.6 million shares at an average price of $55.4 per share. Out of this share count, 18% was executed in the first quarter of 2021, totaling R$232 million. Furthermore, in the second quarter of 2021, we sold most of our minority stake in Cloud Walk, a payment startup in Brazil, for R$209 million, realizing a gain of approximately R$200 million. On page 24, I would like to highlight some key messages from today’s presentation. First, our core SMB business experienced strong growth in the first quarter of 2021, despite short-term impacts from COVID. Based on transactional data from our clients and examples of economic recovery in countries where vaccination is more extensive, we have made an informed decision to increase investments in our business, so we will be prepared to grow faster once our economy returns to normal levels. Second, the strong signs of traction and engagement of current users of our ABC Platform, coupled with digitization trends, have encouraged us to continue evolving our solutions to create a unified financial operating system for SMEs, both online and offline. Third, we are excited about the increased breadth of our brick-and-mortar software solutions, as well as the steps we have taken to assist clients in going digital and how the Linx acquisition will enhance our ecosystem. Finally, we are confident in the continued evolution of our business in 2021, both in terms of our growth and our team’s ability to deliver a strong value proposition to our clients. For these reasons, we have decided to provide you with additional outlook for 2021, as shown on slide 25. Our outlook excludes any impact from the Linx acquisition, as this transaction has not yet closed. For the full year 2021, we expect between 1.4 million and 1.5 million active payment clients, including TON, approximately 950,000 clients excluding TON, a take rate ex-Coronavoucher for the full year between 1.85% and 2%, and significant acceleration in total revenue and income growth compared to the growth levels we observed in 2020.

Yes, sir. And the first question will come from Jorge Kuri with Morgan Stanley. Please go ahead.

Hi everyone, good afternoon. Congratulations on the results. I have two questions. First, regarding the provisions taken for your lending business, how can we be assured that these provisions are sufficient to address the extraordinary risks brought on by COVID? Is there a way to understand how the non-performing loan ratio has changed or what your coverage ratio looks like, specifically the provisions on your balance sheet relative to current non-performing loans? Any insights on these metrics would be useful as we consider potential additional provisions in the future. My second question is about the 2021 outlook page. I noticed the take rate of 1.85% to 2% and would like to understand what influences these figures. Is it simply based on your expectation that if the mix improves, we’ll reach 2%, otherwise we’ll stick with 1.85%? What factors are driving these numbers so we can better anticipate if you might meet the higher or lower end as the year unfolds? Thank you.

Hello. Can you hear?

Yeah. Yeah.

Yes.

Yeah. I can hear you.

Sorry about that. Rafael was answering you, but I think that you were not listening. So I will take the first question and the second one too. Thank you for the question. So, first, regarding provisions in our credit products, there are two very important methods. We are very confident with the level of risk-adjusted return net of funding costs that we are showing, and we decided to open the cohorts for you to see the impact on different cohorts from the first quarter of 2020 to this quarter 2021. Basically, when you see the second quarter 2020 cohorts being mined, we already received 82% of the cash flows from that quarter and we believe we did everything necessary in terms of provisions because of the second wave of COVID. So we are very confident with the level of provisions with it. We think that it’s all done in terms of making sure that the book took all the impacts from the second wave into account. In terms of take rates, the two main drivers are really our ability to scale the SMB operation, as you’re seeing that we are increasing growth in May, and we decided to show the two-year CAGR growing 50% regardless of the impact of COVID in 2020 and 2021, along with our capability to further penetrate additional working capital solutions, which we are doing well. We decided to migrate clients to our new platform, which is much more seamless for our clients to access all their funds and their working capital based on those volumes. We will be ready for the new dynamic of the registry of receivable now on June 7th, and with more collateral, we can provide more working capital to our clients in the form of prepayment and credit and working capital products. So we are very confident with the range that we provided, and as always, we are much more committed to the top of the range as we always have been. So very confident with the provisions and the level of take rates and client base growth that you have provided.

Thank you, Thiago. Thanks for that clear response.

The next question will come from Tito Labarta with Goldman Sachs. Please go ahead.

Hi. Good evening. Thank you for the call and for taking my question. A couple of questions also, I guess, one about margin and the impact from some of the additional investments that you did in the quarter? Would you say those investments, I guess, in your headcount, were that one-time in Q1 and that should go away? You showed in, I think, slide 26, that there was about a 5% impact to margin. If you could just help us think about that going forward? And then, along those lines, I guess, is there a more recurring level of margin, closer to what you show here, like around that 36% giving you like another 9% impact related to COVID and provisions? How quickly can you get back to those levels, given that the take rate seems to be increasing from here now? And then the second question is regarding the partnership with Banco Inter. Thanks for the color on that. Is there any interest in getting closer to the consumer? In the slide, it seems you want to offer a complete platform for merchants, and then Inter can have a complete platform for consumers? But I guess maybe, particularly as you’re growing TON more, do you need to have more products for the consumer? Is that any part of the rationale there, or is it strictly just to benefit your merchant base? Thank you.

Thank you, Tito. Can you guys hear me now?

Yes.

Sorry about the previous question; my microphone wasn't functioning. To address your first question, Tito, we will definitely continue to invest in our business. However, I believe the first quarter had an unusually high impact on our margins due to lower revenue from the provisions. I would say we are already seeing margins improve in the second quarter, and the margins from the first quarter do not reflect what we see as a steady-state margin. Additionally, as we disclosed this quarter, we have made significant investments in our business, even while navigating the challenges of COVID. We do not think those circumstances should hinder our long-term investment capabilities. That said, we are indeed observing an increase in margins again in the second quarter.

And Rafael, I just want to expand on this topic regarding investments. We are truly excited about continuing to invest in growth. The approach for investments in the first quarter was to front-load them to ensure we can grow in the second quarter and throughout 2022. This is an important message, as we remain very confident about growth moving forward. Regarding your question about Inter, I want to elaborate on this deal. We have great admiration for the Inter team; their culture and vision align closely with ours, and they have developed an excellent business focused on consumers. While they are in the same industry, their business model targets different client segments than ours. However, as we work diligently to drive the digital transformation of our merchants, we have learned a lot from them about viewing the commerce revolution from the consumer's perspective. Much of what we aim to build together through these commercial partnerships involves facilitating the digitization of our merchant base by connecting our clients to InterShop. We also plan to assist InterShop consumers in navigating a more multi-channel omnichannel journey of consumption. This is the mindset we have, and we believe there is a lot we can achieve together with them.

Lia, just to add some points here. Tito, thank you for your question. As we always said, levels around 25% to 30% margins are healthy levels. We are committed to maintaining this range. As we always indicate, if we can find ways to grow faster, margins will be closer to the bottom of this range, while if we struggle to identify avenues for growth, margins will be higher. Nevertheless, we are always committed to maintaining our margin levels, as we communicated earlier. We anticipate margins to rise on a quarter-over-quarter basis. We believe the significant, almost one-time impact from COVID and provisions will decline, and as I mentioned, I think we managed to navigate these challenges successfully in the first quarter. Now we expect margins to recover to the levels we are accustomed to seeing. Regarding the Banco Inter investment, as Lia mentioned, we appreciate the team, culture, and their development. We think that we now have a better opportunity to learn more about the financial revolution from the consumer perspective. We stated last quarter that we want to be a key player in the convergence between consumers and merchants ecosystems. So we believe we will be in a position to be close and learn a lot from this partnership. Thank you, Tito, for the great question.

Great. Yeah. Thank you, Thiago, Lia, and Rafael. That’s very helpful.

The next question will come from Rayna Kumar with Evercore. Please go ahead.

Good evening. Thanks for taking my question. I have two. The first one is, could you help us think about how free cash flow or adjusted free cash flow could work for the remainder of the year? Obviously, you already addressed the heightened capital expenditures in the first quarter. But how should we think about it for the remainder of the year? And my second question is, if you can help us frame the evolution of converting your client base into heavy users, which use payments, banking, and credit. Clearly, there is an important dynamic supporting revenue growth acceleration here, and we know that rates were 8% in the first quarter, up from 5% in the fourth quarter. So is there a target penetration rate that you have in mind for this year and next? Thank you.

Thank you, Rayna for your question. Rafael here. So let me answer your first question regarding free cash flow. In this quarter, we had an unusually low free cash flow due to higher CapEx. Whenever we have opportunities for commercial advantages with suppliers, we advance payments, and that’s what we did this quarter. However, looking ahead for the year, without considering that seasonality, we expect to have high conversion rates, similar to what we experienced in prior years. Our business is cash-generative, and we expect that trend to continue moving forward. Therefore, when you consider our adjusted net income and look at our free cash flow, we do anticipate high conversion rates.

And I’d like to take the second question regarding heavy users. That's a great question. The two significant elements here are our customer service operations and how we engage with our clients on a daily basis, as well as technology and product development. We talked a little about how we’ve already migrated 70% of our clients to the ABC Platform. What this allows is for our clients to access all of their solutions seamlessly and to interact with us effectively. Typically, a new client starts with a payments relationship, but over time, that relationship evolves into banking, loans, and various other solutions. Hence, our capacity for effective customer interaction and the integrated experience offered by the ABC platform are the two primary factors that will drive further penetration of heavy users within our available client base looking forward. We are excited about this evolution occurring consistently.

And Rayna, Thiago here. Let me add some quick comments. Regarding our CapEx and free cash flow, we’ve always maintained very strong cash conversion rates in our business and we plan to uphold the same when looking at our forward conversion plans. With this quarter reflecting the impact of the agreement we've made with Grupo Globo, where we were essentially migrating ownership of TON to the StoneCo level while prepaying marketing investments. From this, we expect that our adjusted free cash flow remains high moving forward. Regarding heavy users, the strategy is to keep investing in technology to ensure that alignment between our solutions is robust. Therefore, the new financial operating system we are designing through the ABC Platform will help facilitate this evolution. You can see that we currently have 15% of our SMB clients utilizing the credit product with us. However, we disclosed a new metric, which reveals that 7% of our clients are engaged with prepayments. This signifies significant potential within our client base that doesn't currently utilize our credit or prepayment offerings, as they often rely on other banks for these services. Post the registry of receivables, we will be well-positioned to present more prepayment options, and as we better ascertain collateral, we can provide superior working capital products for them. If we can introduce the best products with outstanding service and dedicate ourselves to enhance our clients' experiences, I believe engagement with our solutions will progressively increase. Thus, it's about commitment to product development, customer service and executing things in the simplest manner possible, delivering the highest quality service to our clients.

Very helpful. Thank you.

The next question will come from Craig Maurer with Autonomous Research. Please go ahead.

Yeah. Hi. Good evening. Thanks for taking my questions. A couple of questions, first on competition, while it’s hard for me to see any real improvement in the actual offering from incumbents. I am curious about your view on the threat from embedded finance from the likes of companies like InBev, who are beginning to offer financial services directly to merchants who are purchasing their goods? Second, could you comment on what the take rates look like on the non-acquiring TPV that you’re seeing through your cards or through bill payments or other aspects? Lastly, I noticed that your cost of sales looked to be up significantly as a percentage of TPV or transaction revenue, so maybe a comment or two to help us think about how we should view that moving forward? Thanks.

Hi, Craig. Thiago here. Thank you for the questions. I’ll start with the competition part. I believe we still compete with significant incumbent players in the market. Those are the players we encounter daily and face competition from. However, I believe we have the ability to expand our client base and increase engagement in our offerings primarily due to the quality of our products and services. In terms of acquiring business itself, our competition remains consistent. While take rates in acquiring have seen a slight decrease, they have been overwhelmingly offset by results from additional solutions. We remain dedicated to creating more engagement through Money-In and Money-Out features, aiming to be relevant in the financial needs of our merchants. Whenever there are changes in take rates, there are two primary drivers: first, we are experiencing a higher mix of debit transactions, and secondly, there's been a slight shift towards a larger SMB, which comes with a lower take rate, but has a significantly higher lifetime value. As we continue to expand our client base, the wait in this payment-first model remains strong. That's why we see take rates not keeping pace with the rapid client acquisition, but gaining speed as we increase prepayments, credit, and working capital solutions. The take rates in Money-In and Money-Out are still small, but our core strategy is to establish engagement levels rapidly. We're putting efforts into increasing features for our clients like payroll, which we believe will offer a substantial opportunity and plan to launch in the second half of the year.

Thanks. And the cost of sales that were up as a percentage of transaction revenue and TPV?

Hi, Craig. Rafael here. When considering our cost of services, several investments contributed to increased costs, particularly in technology and customer service teams directed at enhancing service. Therefore, on an annual basis, these were the main driving forces. If we look at a quarter-to-quarter basis, we also have investments in new solutions like TAG, our registry of receivables as well as banking, right? These factors significantly influence that area, which extends beyond typical transactional technology costs to also include those mentioned.

And Craig, the last comment I want to make is we anticipate that our take rates in the SMB operation will continue to increase based on our experience at creating more engagement where we are expanding our client base. So we expect our take rates to grow progressively and our main competition lies predominantly with incumbents today.

Thank you very much.

Thank you, Craig.

The next question will come from Jeff Cantwell with Guggenheim. Please go ahead.

Hi. Thanks for taking my question. Can you hear me?

Yes.

Okay, great. You’re always very thorough in your prepared remarks. Thanks for that. Maybe let’s just think about, can you tell us more about what you’re seeing in the current operating environment and help us understand what’s been driving that improvement in TPV in April and in May versus March? I wondered if you could drill down on that for us because we’ve been focusing on what’s happening with your core, call it, ex-Coronavoucher growth in TPV? Is it SMB driven, where do you think you’re gaining market share right now, and is there any noticeable change in the mix debit versus credit? Just trying to get a sense of what happened since the end of the first quarter? Can you help us get a sense of why you feel the company is moving past the bottom, so to speak? Thanks.

Hi, Jeff. This is Lia. Thank you for the question. Regarding TPV evolution, the more recent TPV trends, I think, as we mentioned at the start of today’s presentation, show that as restrictions ease, the comeback tends to be fast. So yes, the TPV growth we’ve seen is primarily driven by SMBs, and as restrictions ease more, we expect that swift comeback to continue and that’s why we emphasize the importance of our investments to scale our operation as we recover. I think that’s the primary takeaway regarding the color of TPV growth.

And Jeff, Thiago here. The TPV growth is predominantly driven by our SMB operation expanding rapidly. Had it not been for the second wave of COVID in the first quarter, we would have seen even stronger growth. However, we are optimistic regarding the increasing client engagement facilitating improved growth in both TPV and the overall client base. The evolving dynamics in the client profile suggests we retain larger clients now than before, which positions us positively as we expand our offerings. So the TPV growth we are experiencing in April and May is hence strongly linked to a resurgence in activity from our SMB base. If it hadn’t been for the lockdowns and the subsequent second wave of COVID in the first quarter, the growth would have been much more pronounced. We’re expecting continued upward trends throughout the year.

Got it. Got it. Great. And then my other question was, I guess, this is more high level, but why increase investments now? I guess the question is what’s the calculation that you’re making about the future normalized environment? It seems the timing of these investments and this new product launch, the unified financial operating system, and partnerships announced with Linx— I guess the point is that these will drive faster rates of topline growth for you guys, which makes sense? So I just wanted to see if you could tell us more about this timing and where these investments could lead to incremental revenue opportunities for you. Could you maybe highlight some of the areas where you’re seeing opportunities in the market? Thanks.

Great, Jeff. That’s an excellent question. So there are mainly two factors driving this decision. As I mentioned previously, learning from the first wave of lockdown last year was critical. Last year, when COVID emerged and lockdowns were imposed, we acted quickly to resize our operation, resulting in a smaller operation. Consequently, when client activity rebounded, we faced challenges meeting demand. We've learned that lockdowns negatively impact business, demanding us to remain agile in responding to changing conditions. We’ve observed across other countries that once vaccination efforts scale, economic recoveries are typically rapid. Hence, we’ve decided to maintain our commitments to investing in operations to be prepared to hit the ground running post-recovery, and the growth of both our April and May figures reflects the good approach we chose. So we will continue to invest in our operation, maintaining that balance between growth and margins. Nonetheless, we believe that the experience from the previous year and the quantitative data we are gathering from our clients suggest we remain in the right direction for future investments.

Okay, great. Thanks for all the color. Appreciate it.

Thanks, Jeff.

The next question will come from Jamie Friedman with Susquehanna. Please go ahead.

Great. Thank you very much for taking my question. I just had two quick ones. The April and May TPV growth rates look great. How should we think about Q2 take rates? Are there still any major voucher impacts that we should be thinking of? And then the second question is when it comes to active clients, it looks like for 2021 you’re now targeting about 950,000 excluding TON. Can you talk a little bit about the cadence for those and how those adds work through Q2, Q3, and Q4?

Hi, Jamie. Rafael here. Thank you very much for your question. So regarding your first question on take rates, yes. We do expect take rates to increase in the second quarter. I would say that the first quarter represented sort of a bottom in terms of take rates. Coronavoucher volumes may still have some minor impacts, but not very significant compared to what we experienced last year, and so that's a trend we are seeing. Hence, we are quite comfortable providing the guidance we did, envisioning take rates for the full year to be in the range of 1.85% to 2%. We’re already starting to see this improvement in the second quarter.

Let me add some comments here, Jamie. Two things: As we provided guidance surrounding take rates for the year, we anticipate a significant increase in take rates for the remaining quarters. We are seeing improvements in second-quarter take rates, which are substantially better than those of the first quarter. We do not expect Coronavoucher implications to be particularly significant this year, so the take rates ex-Coronavoucher should not exhibit much difference in what we expect for this year. Additionally, Pagar.me will continue to grow in volume, albeit not at the same pace we observed last year, but it will still grow. Therefore, we expect the range of approximately 1.85% to 2% in take rates means our SMB operation will be magnifying LTV, thereby increasing the engagement of newly offered solutions, and we expect considerably higher take rates moving forward.

And Jeff, I believe you asked about the active client base at the end of the year, right?

Yes. I did. Thank you.

Yeah. So just to address that point. Yes, we’ve provided guidance of 950,000 clients by the end of the year excluding TON. We expect that the cadence of net adds will continue to increase throughout the year. We emphasize the message Thiago mentioned earlier: we expect restrictions will ease as vaccinations proliferate in Brazil. Once that happens, we are, again, front-loading for growth, which would include reaching around 350,000 agents on the streets in the fourth quarter of 2021. Therefore, we anticipate the cadence of net adds will increase as the year progresses. It’s important to note that we did see impacts from the second wave lockdowns in the first quarter, which we anticipate will recover.

Thank you. So we will work hard to return to and exceed previous metrics.

The next question will come from Mario Pierry with Bank of America. Please go ahead.

Hello, everyone. Good afternoon. I'd like to revisit the credit business, specifically the provisions for Pagar.me. According to my calculations, you've set aside R$116 million in provisions, which is about 8% of your average portfolio when comparing the first quarter to the fourth quarter. My question is whether this issue was related to a particular client or segment. What insights have you gained from this experience? Why was there such a rapid increase in provisions? Does this indicate that you were under-provisioning or perhaps too optimistic with your expectations? Will this necessitate changes in your pricing strategy going forward, and how might it affect your willingness to lend? We've also noticed a slight decline in originations this quarter. Should we expect this trend to continue, or do you believe you've resolved the issue? Is this an isolated incident, or can we expect a return to normal operations?

Hi, Mario. Thanks for your question. Rafael here. The provisions we've set up primarily relate to older cohorts. We need to provide our best estimate when we have our numbers ready. We didn’t account for a second wave of COVID in our previous estimates, which is why we are provisioning now. Looking ahead, our newer cohorts show better returns. For instance, as Thiago mentioned, clients from last year's second quarter have already returned over 80% of the cash we expected. This makes us comfortable with those levels and doesn’t affect our willingness to offer credit to grow our solution. We remain very optimistic about our opportunities. The market for our credit solution is still in its early stages and presents a significant opportunity. Even considering expected delinquencies, we’re seeing returns of around 2% a month net of those delinquencies. This is a very healthy return, and we are excited about the working capital solutions for our clients.

Okay.

Mario just to complement a little bit, Thiago here speaking. I think that the reason why we decided to open the cohort for different quarters is to show you that the major impact was the first quarter of 2020. At that time, our model was not ready to deal with lockdowns and to fully understand the ramifications for specific types of clients subject to extended periods of lockdowns. Some of our clients are no longer in business. So we had to adjust our models throughout the first quarter and early second quarter to reflect those insights. I think we have done the necessary adjustments based on lessons learned from last year’s cohorts, and we are looking at those to move ahead without reducing our credit appetite. In fact, it’s the opposite, because if you can operate during challenging environments with a healthy level of returns, it improves our capacity to offer more working capital to your clients. We must, however, do that in a cautious manner. The most significant aspect is creating a product that our clients need, understand, and acknowledge as valuable – that is the priority. The second aspect is our ability in crafting those products with profitability that we feel comfortable scaling. The third is our capacity to raise capital from third-party partners to mitigate our credit risk and funding exposure. This is why we are pleased with our ability to secure additional capital. As Lia said, we now have more than R$ 800 million committed from investors. I believe we have executed the correct processes in the prepayments in the past similar to credit today. We are putting some of our funds to initiate this product and will then scale it using third-party capital, just as we did with prepayments. So we are confident in our working capital solutions and credit outlook; the lessons learned throughout the COVID crisis will be invaluable for the future.

Okay. If I look, right, at your loan book in the first quarter it was about R$300 million; the second quarter was about R$500 million. So you’re averaging about, let’s call it, like, R$450 million. And then now you have to increase your provisions by R$116 million. It just seems like a very large figure for the size of the loan book. So then I go back to the question, was this specific to one client or really it was across the board?

Hi, Mario. No, this was not specific to one client. Our client base is very dispersed. If we consider client concentration in credit, it’s relatively minimal. So it’s indeed related to the lockdown scenario that impacted many thousands of merchants, with no specific client or concentration issues present.

And Mario, just to provide additional information, I'll confirm this with the team, and we can follow up offline. However, I believe the largest check we provide in terms of credit is about R$150,000. Based on this, we don't serve significantly larger clients, right? The challenges we faced last year revolved around insufficient experience in managing lockdowns, which helped us to determine how to navigate these credit products effectively. We retained some segments that were heavily reliant on brick-and-mortar operations. So the issues we faced weren't centralized to specific clients or segments but were a result of poor performance during lockdowns, and this highlights the valuable lessons we took away.

Okay. Thank you very much.

Thank you, Mario.

The next question will come from Neha Agarwala with HSBC. Please go ahead.

Hi. Thank you for taking my question. I'll quickly follow up on Mario’s previous question. Could you give us a sense of what is the NPL ratio for your loan book? Just a rough range, and how that has changed to gauge if we can see any additional provisioning in the coming months? My second question is about proximity move to the SMB segment. I believe in the first half of this year, they have also been more aggressive in opening more hubs and hiring more people on the street. Has that impacted your merchants, the clients that you target, and have you been hearing more about them from your merchants? Any insights on the competitive dynamic from proximity would be helpful. Lastly, on Inter, with this partnership, do you have an ambition to go beyond being the pure B2B player and really develop a relationship with the end consumer? Maybe not today, but maybe in future years. Is that a vision you have?

Hi, Neha. Thank you for your question. Rafael here. So when we look at our expected delinquency rates, they are slightly above 10%, around 12% or so. When we consider pre-COVID levels last year, we were discussing figures like 8%, so this is the rise we have noted. As I indicated, when we analyze cohorts from the second quarter of 2020, we have already received over 82% of what we lent, outlining the risk increase we have witnessed.

Neha, regarding your second question, this is Thiago speaking. Competition remains at a similar level to which we have consistently experienced. Our major competitors are still the big banks and established players. While we don't comment in-depth regarding the movements of competitors, we focus on serving our clients with the best possible solutions. I believe we possess the best value proposition for SMBs, which stems from the offerings, service quality, and our engagement levels. The growth numbers we have presented underscore our role as the premier player in the SMB sector, and we will continue to lead the financial services revolution for SMBs throughout Brazil. Regarding Banco Inter, we’re not shifting towards consumers per se but aiming to understand how consumers interact with merchants to enhance our services. Ultimately, our goal is to support our clients with their financial needs as well as help them grow. Thus, it’s about learning rather than merely expanding our consumer base.

Understood. One additional question on the credit, the average duration of your portfolio seems to be increasing—it was about seven months earlier last quarter, eight months this quarter, and now nine months. Could you provide any color on why this is the case and what the normalization looks like in the coming year?

Hi, Neha. Thank you. So there is some elevation in that aspect, which occurs when our clients take credit for the second time. If they have fully paid the initial loan, then they may seek additional credit. Thus, we tend to offer a slightly extended term for them. That’s why we are observing this trend. Of course, as we grow more comfortable and learn, as Thiago mentioned, we can extend a little more in terms of the duration offered.

To add one more point: as Rafael mentioned, regarding product durations, two factors contribute to the average length. Firstly, the average size we provide is roughly equivalent to one month's sales of our clients. Secondly, we recognize that many of our clients who completely settle their loans often wish to engage with us again for additional credit. Consequently, we slightly adjust duration to accommodate easier payments based on more consistent clients, thus increasing our capacity for credit. This reflects our ongoing commitment to placing our clients in a position to operate comfortably.

What is the maximum duration that you’re offering?

It should be around 10 months; I don’t think we have anything much longer than this.

I think average duration is nine months; therefore, the maximum will be around ten months.

Okay. Great. Thank you so much for the answers.

Thank you, Neha.

Thank you.

There are no questions at this time. This concludes the question-and-answer session. I would now like to turn it over to your host for final considerations. Please go ahead.

Hello, everyone. Thiago here. Just want to say a big thank you to everyone and a huge thank you to our team for all their hard work in serving our clients during these difficult times. You can continue to count on us working hard to help merchants navigate this situation and enhance their operations. Thank you, everyone. Bye-bye. See you in the next quarter.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.